RBI move on CRR dashes hopes of banks cutting lending rates

Cost of setting aside 100% of aggregate deposits garnered between 16 September and 11 November as CRR for a fortnight will be negative, say experts


RBI has said that it will review its CRR decision on or before 9 December. Photo: Bloomberg
RBI has said that it will review its CRR decision on or before 9 December. Photo: Bloomberg

Mumbai: The Reserve Bank of India’s (RBI’s) decision to pull out excess liquidity from the banking system in the form of cash reserve ratio (CRR) has dashed any hopes of a lending rate cut by banks in the near future.

Experts said that the initial cost of setting aside 100% of net demand and time liabilities (NDTL)—or aggregate deposits—garnered between 16 September and 11 November as CRR for a fortnight will be negative.

According to various estimates, the NDTL that banks earned during this period is more than Rs3 trillion.

The move, which was announced on Saturday, was aimed at reducing excess liquidity created in the system after customers queued outside bank branches to deposit their old Rs500 and Rs1,000 notes that the government said would not be legal tender after 8 November.

The banking regulator has said that it will review its CRR decision on or before 9 December.

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CRR is the mandatory holding that banks must maintain with the regulator and RBI does not pay interest on this.

Banks, however, have to continue paying 4% annual interest on deposits that are held in their savings accounts. This will hit their interest income, as their money will now lie with RBI instead of being loaned out.

“Over and above the obvious impact of a decline in bank revenue, there is also a negative carry component of CRR in the lending rate calculation. So, if CRR is hiked, the possibility of transmission comes down,” said Anshula Kant, chief financial officer (CFO), State Bank of India (SBI), without quantifying what the direct impact of such a move by the regulator would be.

According to the RBI’s formula for calculating the marginal cost of funds-based lending rate (MCLR), the negative carry on CRR is an important component in calculating marginal cost and, therefore, the lending rate.

Another problem for banks is that a lot of the money that customers deposited in their accounts is still lying in bank branches. Until currency is deposited in RBI’s coffers, it cannot be counted as CRR and continues to be classified as ‘cash in hand’ at bank branches.

With RBI’s 100% CRR order effective from Saturday itself, banks have had to borrow Rs3 trillion from the central bank’s repo window on Monday to fulfil their deposit requirements.

The central bank conducted the record repo auction in two tranches, with a weighted average interest rate of 6.35% for Rs2 trillion and 6.27% for the remaining Rs1 trillion. The previous highest repo auction was Rs2.81 trillion on 31 March.

“Hopefully, 100% CRR is only a temporary measure and will soon be removed in favour of measures like market stabilization scheme where the government will issue interest-earning securities against the excess liquidity,” said the executive director and CFO of a large public sector bank, seeking anonymity as he is not authorized to speak to the media.

According to a report by CARE Ltd on Monday, by making banks deposit Rs3.24 trillion with RBI, the total cost for banks on these deposits will be Rs18,110 crore on an annual basis as this amount has to be paid to the customers.

“If these terms on CRR are diluted, in course of time, the cost will come down commensurately,” the CARE report said, adding that the RBI’s monetary policy decision would be key to understanding how interest rates in the system will move.

“If large banks like SBI are saying that they will find it difficult to pass on lower rates on the lending side, then it will surely be an issue with other mid-sized banks as well,” said Abhishek Bhattacharya, director and co-head, financial institutions, at India Ratings & Research Pvt. Ltd.

“However, it must also be noted that even before demonetization, banks had barely touched their base rate, which means that a large part of the loan book wasn’t seeing much transmission at all,” he added.

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